Federal Reserve Board Chairwoman Janet Yellen Getty Images
“Man plans and God laughs.” So says the sage Yiddish proverb. Despite our experience, we still think we can actually map out plans for the future with a degree of accuracy greater than a coin flip.
In that vein, the Federal Open Market Committee Wednesday projected it would raise its key federal funds interest-rate target by a quarter percentage point three times in 2017, which was one more hike than in its previous forecast announced in late September.
That followed an actual quarter-point boost to its fed funds target, to a range of 0.5%-0.75%, which was totally expected—largely because it was only the first move by the Fed during all of 2016.
Recall that at last December’s FOMC confab the panel had projected four quarter-point hikes after the initial liftoff in the funds rate from near zero, where it had been held for seven years during the financial crisis.
That forecast was given increased credibility the following month when Fed Vice Chairman Stanley Fischer allowed that four increases for 2016 were “in the ballpark.”
Those plans went somewhat awry, however. A March hike was shelved after the steep slide in global markets at the beginning of the year over concerns about China and the plunge in oil and other commodity prices and its effect on the high-yield market. By June, concerns about the U.K. referendum whether to leave the European Union kept the Fed on hold. In September, uncertainty following tepid first-half data and the looming U.S. election kept policy on hold.
With the election out of the way, U.S. economic data coming on the strong side and major stock indexes setting records, there were no more reasons to avoid rate hikes by the Fed. That was especially the case with the unemployment rate falling to a cycle low of 4.6% in November, which appeared to have played a significant role in the shift in the Fed’s future stance, Goldman Sachs economists Zach Pandl and Jan Hatzius write in a research note.
At her post-meeting press conference, Fed Chair Janet Yellen backpedaled from the notion of running a “high-pressure” economy, which she raised in a recent speech. The idea would be to coax some workforce dropouts back into the market. The decline in the headline jobless rate last month largely was the result of a renewed decline in the labor force participation rate back to a cyclical low of 62.7%.
Be that as it may, the 4.6% unemployment rate is below the 4.9% rate Fed economists see as full employment. Yellen compared the current jobless rate to that of 2007, when the job market was at full employment at the peak of the previous economic cycle later that year. But the more inclusive U6 unemployment rate, which takes into account workers working part-time for economic reasons and “marginally attached” people, then was almost a full percentage point lower than the current 9.3%.
That said, the anticipated changes in fiscal and regulatory policies by the incoming Trump administration did not play a role in the FOMC’s shift in its expected rate hikes for 2018.
“We’re operating under a cloud of uncertainty at the moment,” Yellen said. “We have time to wait to see what changes occur and factor those into our decision making as we gain greater clarity.”
For their part, the markets haven’t waited until those clouds disperse. They have pushed stock prices, bond yields and the dollar sharply higher in anticipation of fiscal stimulus in the form of tax cuts and infrastructure spending along with an easing of growth-hindering regulatory constraints.
Much of the latter can be accomplished by Donald Trump’s signature as soon as he is inaugurated as president on Jan. 20. Tax and spending changes have to be enacted by Congress, which Horizon Investments’ chief global strategist Greg Valliere thinks could happen more quickly than most expect.
Surely the Republicans who now control both the Senate and House of Representatives would want nothing more than to deliver sweeping tax cuts and reforms to the desk of President Trump as early as possible.
But if the surprises of 2016 teach us anything, any number of unforeseen events may intercede. And even if those best-laid plans do come to fruition, there are likely to be long and variable lags as to when their effects may be felt.
The same goes for the Fed. According to the CME ’s FedWatch tool, the fed funds futures market is only putting a 51% probability of funds-rate target of 1.25%-1.50% (or higher) by next December. In other words, chances of a third quarter-point hike next year are as good as a coin flip.
Given those odds and the events of the past year, God may be in for lots of laughs in 2017.